The Balanced Money Formula

Building a budget is one of the basic tasks of personal finance. But not everyone can keep a budget. As much as I'd like to, I don't feel comfortable with detailed planning. I continue to use a spending plan as a rough guide to my future, but a traditional budget just doesn't work for me.

Last night I stumbled across the Balanced Money Formula proposed by Elizabeth Warren and Amelia Tyagi in their excellent book, All Your Worth: The Ultimate Lifetime Money Plan [my review]. Like my spending plan, the Balanced Money Formula is an alternative to traditional budgets. Though I considered this concept a little “light” in the past, it really hit home yesterday. It helped me to realize that my own spending has become unbalanced.

The Balanced Money Formula

The Balanced Money Formula is based on your net income (your income after taxes). Warren and Tyagi say that, ideally, no more than 50% of your paycheck should be spent on Needs (and keeping them below 35% is best). Of the remaining amount, at least 20% should be devoted to Saving, while up to 30% can be spent on Wants.

Here's what it looks like:

That's it. Simple. Three categories. No detail. This is the sort of Big Picture budget that I find useful, and in this case I could see that there was something wrong with my Wants. Here's how the authors define these terms:

As in the list of tips I shared a few days ago, Saving comes last in this plan. Everything left after you take care of Wants and Needs is set aside for the future. (If you want to get out of debt, that's also tackled here.)

Warren and Tyagi write:

When your money is in balance, you always have enough to pay your bills, have some fun, and save for your dreams. And here is the best part of all. Once your money is in balance, you can stop worrying about it. Managing your money becomes automatic.

This Balanced Money Formula is a goal. It's an ideal. If you're just beginning to manage your money, your financial life will probably be distinctly unbalanced.

For example, if your income's small (or your mortgage is large), you might be spending 80% (or more) on Needs. If you are a compulsive spender, if you like to dine in fine restaurants or to collect Hummel figurines, you might be spending 45% of your income on Wants. And, of course, few people starting out can afford to set aside 20% of their income for Savings.

Here's what that might look like:

Small income/Large mortgage

Needs: 80%

Wants:15%

Savings:5%

Compulsive spender

Needs: 50%

Wants:45%

Savings:5%

Here's how your budget might be out of balance if you're trying to reach a goal:

Someone trying to build their emergency fund

Needs: 40%

Wants:25%

Savings:35%

Someone who is financially independent

Needs: 30%

Wants:55%

Savings:15%

The authors say that your goal should be to move from your current state to something more balanced. For some, that's as simple as re-prioritizing expenses. For most, it's not that simple.

When your Needs are too high, for example, you severely cramp both Wants and Savings. Because most of your income goes to necessities, you don't have enough for fun or for the future. To remedy this, you might need to take drastic action. You might need to move into someplace more affordable (perhaps even to a different city). You might need to find a better-paying job. These are not easy steps.

Life Out of Balance

In many ways, the Balanced Money Formula is brilliant. I agree wholeheartedly that Needs should be kept under 50% of net income. (I think it's a good idea to split Needs: about 25% for housing, about 25% for all other Needs.) I also agree that saving at least 20% of your income (or using that money to repay debt) is an excellent way to find the path to wealth.

But what about that 30% for Wants?

Warren and Tyagi write, “You can spend your Wants money on anything that strikes your fancy, so long as you stay within 30% of your income.” In fact, they warn against spending too little on Wants, suggesting that those who spend less than 20% of their income on the things they enjoy might be missing the point of money. “You certainly won't get into trouble spending like this on Wants,” they say. “Even so, you should ask yourself — are you making enough room for fun?“

Excellent question, and here's the truth: I'm spending less than 10% of my income on fun, and I can tell. I'm growing a little cantankerous in my old age. I'm letting things like a trip to the movies raise my blood pressure, when I should just be enjoying life. I've paid off my debt. I'm not spending foolishly. I can afford to go to a movie, even if it is expensive. I can afford to spend the extra 29 cents to have a great mug of cocoa.

All Work And No Play

I've written a lot lately about frugality, and I'm not about to give up my frugal ways. Thrift has been successful for me, has helped me to build wealth. But as some readers have noted, one reason to save money is to enjoy it. It's not just for the future, but for today. Re-visiting the Balanced Money Formula last night brought this point home to me.

I've allowed my own money equation to become unbalanced again. Over the past few years, I've become a Super Saver. Initially, this money went to debt reduction; now it goes to saving and investing. I'm proud of paying off my past and providing for my future, but maybe it's time to spend a little money on today. Maybe it's time to indulge myself. Maybe it's time to give myself a budget for fun.

The Balanced Money Formula puts a lot of minds at ease. It can definitely help you put your finances in automatic mode. But its simplicity also lends itself to being applicable to other life circumstances. If you're reaching for a goal, letting yourself get out of balance with the formula is what naturally happens. I also think being out of balance is something that should last only for a certain period of time, but what do you think?

To learn more about the Balanced Money Formula, borrow the excellent All Your Worth from your public library, or check out this interview with the authors. Photo by SuperFanastic.

In 2006, J.D. founded Get Rich Slowly to document his quest to get out of debt. Over time, he learned how to save and how to invest. Today, he's managed to reach early retirement! He wants to help you master your money — and your life. No scams. No gimmicks. Just smart money advice to help you reach your goals.

This seems like a good system, though I personally would have put more money towards saving/investing.

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Prateek Jain

11 years ago

Well, its a great concept. I think the crux of this concept lies in its simplicity. I am student and still not earner but I guess this tip will work wonders for me in the future.

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Andy @ Retire at 40

11 years ago

I’ve also dabbled in an overall view as well as budgets. I’m still not quite sure which I like most though I did write an article on 3 Simple Schemes to Split your Paycheck. I also included 30% ‘Wants’ in one of the schemes 🙂

I think I’ll give each system another try and see which one I favour most.

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phil

11 years ago

My only problem with this formula is that it doesn’t leave any money to give away. Maybe your budget will be balanced, but you may become spiritually unbalanced. In my opinion, at least 10% should be budgeted towards charity. It doesn’t matter if you are religious or not. Giving away at least 10% helps towards cultivating the right attitude towards money and enables you to become a positive contributor to your community in ways other than just buying stuff from corporations. Money then becomes a tool and not a goal itself. If money is the goal, your life can become… Read more »

The way I see it, I already give money away to “charity” every paycheck in the form of taxes that are used to support medicare, social security, entitlements, etc.. Any additional giving should come from the “want” category. It is not a need to donate money to charity but you should want to donate what you can. Unfortunately, with the rising cost of education, and my own retirement there is not a lot left to give – and certainly not another 10%

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Filip

11 years ago

This is a great post. Its good to be reminded of the basics once in while.

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Pat with SPI

11 years ago

Hi J.D. “Are you making enough room for fun?” This quote struck a chord with me. I think that I might be saving too much right now, and my “saving percentage” is at about 60%. When I spend money on something, I feel a little sick because I’m so used to saving, and I don’t think that’s such a good thing. In my defense, I think it’s because I’m saving for something that I want later on. My fiancee and I are living in each of our parent’s home right now because we’re saving for a wedding in February. Also,… Read more »

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binny

11 years ago

JD this is a great post. This is exactly how my husband and I have structured our budget (although ours is 40% needs, 30% wants and 30% savings). We have also balanced our savings so that it is 20% long term (saving for a house)and 10% short term (holiday/new car/etc). Being in Australia our retirement savings are automatically taken out of our gross pay so we don’t need to wory about that aspect. I thin that once debt is erradicated and you have worked out what your needs are consistently this is a really good budget to use but I… Read more »

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Paul

11 years ago

I guess in order to sell books, you have to come up with the magic formula.

I think that approach is nominally helpful. The proper approach, IMO, is to build your budget based on long and short term goals. That might mean your savings bucket is 50%. Might mean it’s 5%.

There isn’t a cookie cutter answer that works for everyone, and assuming there is can be couterproductive.

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David

11 years ago

Phil, I think tithing (or charity giving) could be placed under “needs” or “wants” – depending on your perspective. I don’t see why it should be given its own category.

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Don

11 years ago

That is absolutely one of my favorite financial books, and the one I gave my friend to inspire her to get control of her finances. I’m glad to see you’ve rediscovered it.

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JimmyDaGeek

11 years ago

I find these money ratios to be arbitrary. Savings should come first, then needs, then wants. The problem for people is categorizing everything properly and putting everything into balance. Being a miser is no fun because you might die tomorrow and being a spendthrift is a blast but you might not die soon enough.

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sabrina

11 years ago

My question, when it comes to things like this, is where does retirement savings, specifically, come in? Is it a ‘need’? (It is.) Is it ‘savings’? (Yep.) How about after-tax vs. pre-tax? Do I count the 401(k) contributions, or how about IRA vs. cash savings? I can’t decide. I sort of ignore the 401(k) contributions now (since they’re magic and in the background, so mostly I just pay attention to how crappy the balance on that account is, lately 🙂 ) but the IRA thing confuses me. I guess it’s not critical, it’s just confusing when people throw blanket statements… Read more »

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J.D.

11 years ago

JimmyDaGeek wrote: I find these money ratios to be arbitrary. The authors explain the reasoning behind their choices in the book. They also make it clear that different people will have different situations, and so the actual balanced formula for you may be different. The main formula is a good “rule of thumb”. If your Needs are below 50%, you’re in less danger of being sideswiped by disaster. If your Saving is at least 20%, you’re doing a good job of building for tomorrow. They do say that they consider getting Needs under 35% ideal. And since they still think… Read more »

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Dotty

11 years ago

I agree with Sabrina! I’m currently a graduate student living off a very low income ($1000/month CDN). I do occasionally get a research assistantship that helps, but that is never guaranteed. Sixty-five percent of what I earn generally goes to fixed expenses. I have been putting money aside every month for “savings” and “retirement”. And any time I receive unexpected money, it goes right into my savings. In total, I’ve put away $4337 (thanks to blogs such as this one – shout out to JD!). But I am a bit confused about where my retirement fits in, and frankly, whether… Read more »

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Sam

11 years ago

First, I love the photo of the dog with his “Bucks.” Two, I’m a big fan of Elizabeth Warren so I’m going to plan to pick up this book and give it a read. Having a real budget is something we’ve been thinking about, but we have not yet gotten past the spending plan phase. The thing I don’t like about a budget is it ends up being too rigid for us. If I want to spend more on eating out one month or spend more on clothes one month I just want to do it. Which is why I… Read more »

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Melanie

11 years ago

I read this book last week, and also loved the big picture they offered. It really showed me why we were having so much trouble saving– our needs were well in the limits (46%)– but our wants included two big budget items: private school tuition and giving to our church and other organizations. Those are wants– not needs– and it helped us say, well, those are things we’ve chosen (and school only lasts till 8th grade, not much longer), so that means we’ll have less to spend on movies, etc. But it explains why we’re tight, and now we understand… Read more »

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Ann

11 years ago

I just had to say excellent choice of photo!

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Chris H

11 years ago

Does anybody have a suggestion for tracking gas costs???? I do get reimbursed by my company for driving with them, but I tack about 500 miles a week on my car and currently spend more for gas then I do on rent (it all eventually gets covered, but I confuse myself when trying to work percentages). It may be a unique situation, but almost 35% of my take-home pay is spent and then reimbursed for transportation, so it’s gotten a bit crazy. Any suggestions on how to qualify that? P.S. If the 401k contribution is taken out automatically (like most… Read more »

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Lilblueyes

11 years ago

Great post! I decided to work up my own numbers, and based on this method I am currently: 50% needs 28% savings (401k + other savings) 22% wants I must say – before even calculating this – that I have been feeling lately that I am now finally at a very good point financially in my life … and this “budget method” seems quite on-target to me. If only I had followed this method sooner in my life! In my 20’s and early 30’s my budget was more like: 90% needs (huge mortgage), 15% wants, -5% savings (credit card debt… Read more »

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Seth

11 years ago

I’ve followed your blog for some time, but this is my first response. I read All Your Worth a few years ago while working for a library and it made me realize that I, too, was allotting too little for wants. Each check I would send every extra penny to the credit cards, just to turn around and put stuff back on them. However, if I started out by allotting closer to 30% to my wants, I stayed within my budget. I didn’t feel deprived and my credit cards have been steadily going down. I think it’s just a matter… Read more »

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NickShine

11 years ago

I really appreciate this posting. I was missing a basic concept to pin all the complex tracking and ideas etc around. This is it! One can make this as simple or complex as they want. Also, about the “giving” comment- I’d track it under “wants” as one would “want” to give- not “have to”.

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Brooklynchick

11 years ago

Recently read the book from the library and really liked it. As someone with not much head for details, having broad ratios really helped me.

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Sam

11 years ago

Good post. As for the not spending enough on Wants, what I would say is keep the discipline and don’t spend on trinkets that don’t entertain… but on things that will last longer or not fill your house. I’d spend it on a cool vacation.

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RC

11 years ago

Where do student loans fall into this? I would guess under the Needs column. If that’s the case I am at 64% needs, 23% wants, 13% savings. I’m actually kinda surprised I’m not over 30% on wants already.

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Ethan Gunderson

11 years ago

Yes, where do student loan payments fall into this? Also, does anyone know how to set something like this up in mint?

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Moneyblogga

11 years ago

If you’ve been a super saver for the past few years, you deserve to cut yourself some slack. I would imagine by this time that your financial position is more secure than it was back when you started right? We’re just starting out on the road to financial solvency. I know what you mean about becoming a fun deprived grouch though. It’s no fun at all but I guess it’s the price that has to be paid for all the other years of having too much “fun” perhaps. Maybe you’re just a little afraid that upping your fun money allowance… Read more »

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JenK

11 years ago

Looks like a good way to categorize things & decent rules of thumb. This made me laugh: I’m letting things like a trip to the movies raise my blood pressure, when I should just be enjoying life. Trips to the movies usually raise my blood pressure too, but it’s not because I’m not enjoying life, it’s because I’m not that jazzed on the moviegoing experience and there’s usually a dozen things I’d rather be doing. The last movie I completely enjoyed was Sex & The City, because we went to a special theater that was 21 only, had a bar,… Read more »

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Cindy

11 years ago

Thanks for this post. I’ve been enjoying your blog as my husband and I work towards our goal of getting out of debt and on the path towards building wealth. I’m happy to say that if I count all the money going towards debt payoff as “savings” then we’re right on track with this formula. And I feel like we’re in a good place. We’ve cut out expenses and are doing our best to pinch pennies, but still leaving room for plenty of fun. Anyway, this post helped me to realize that maybe I shouldn’t try to cut more of… Read more »

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allen

11 years ago

Theoretically, if you want to live in a more exspensive/nicer place, you could justify taking more out of your “wants”, i suppose.

Still, 50% for someone in their 20s can be VERY hard, if not impossible. :[

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wanzman

11 years ago

I just calculated mine. I am 23, married. This is calculated on take home pay, ie. after taxes, benefits, and 401k savings.

45% Needs 19% Wants (Includes church giving) 36% Savings

I live in Oklahoma, so the cost of living is relatively low.

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Tyler Karaszewski

11 years ago

There are a lot of things that I’m not sure how I’d categorize them based on this system. Is my 401k contribution savings, or is it not counted at all because its not “net” income? (Someone else already mentioned this) Is my car a need or a want? The post says transportation is a need, but I specifically spent an extra $6k or so on my car to get the turbocharged sport model, when I could have got the standard model and drove to work in that one just fine. I don’t think the upgrade to the higher-end car really… Read more »

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Diane

11 years ago

I read this book last year. To answer a few questions: Needs are things you *have* to have, either because of basic dignity (shelter, basic clothes, basic food) or because you are contractually obligated. These are things you would have to pay even if you lost your job and had no money. A cell phone might be a want, but if you have a contract it is now a need. You have to pay it. Savings target actually comes *before* wants. Anything else is a want. This includes food and clothing over and above the basics. Charitable giving could be… Read more »

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Ulyana

11 years ago

Goodness, I either have too many necessities or need to make a ton of money :))) I’ve always suspected that my needs are too high. But since they are needs/necessities, it’s very hard to get rid of them. I’m working right now to free up that category from my car payment (and once the car is paid off, i can get a cheaper car insurance) and student loans. Once I take care of these two, I will be right at 50%. Living in a cheaper place is not an option as I live in San Diego and going cheaper would… Read more »

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Chett

11 years ago

I think the percentages, like JD mentioned, are not hard and fast rules. It really depends on when you started saving and investing. If you began at age 20 saving 20%of your income and continue until age 60, you could expect to be in great shape financially and could probably start by saving a smaller percentage at such a young age. However, if you are 47 and just now starting to save for retirement your percentage that needs to be saved may be much higher than 20%, depending on how much money you want to have when you retire. Still… Read more »

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RenaissanceTrophyWife

11 years ago

I’ve been looking at my budgeting like this for a while, based on the msn article on a 60%/40% breakdown. Theirs is based on gross income so taxes are factored in. 60% goes to committed expenses, including housing, food, charity, all bills and taxes, and basic clothing needs. The other 40% is broken down into 10% for each category: retirement savings; long-term savings, doubling as an emergency fund; short-term savings for irregular expenses; and fun money. It helps me to sub-categorize my savings, but essentially it’s the same plan outlined above except 60% needs, 30% savings, and 10% wants. http://articles.moneycentral.msn.com/SavingandDebt/LearnToBudget/ASimplerWayToSaveThe60Solution.aspx

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Rainy

11 years ago

Well, it’s a great ideal and a great guide, but not exactly realistic for everyone. If you live in an area with a ridiculously high cost of living, for example. My rent alone is 60% of my net income. That’s way too high, but “moving to a cheaper living situation” isn’t really possible unless I want to move somewhere really unsafe. And the really funny thing is, I have a total steal on my rent. It’s waaaay under the mean for my area. It’s an ideal to aim for, at least. And I am now debt free and do manage… Read more »

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Kristen at The Frugal Girl

11 years ago

Dear me…I’m really supposed to be using only half of our income for needs? Our mortgage alone would eat up nearly all of that, after taxes(I live in the Baltimore/DC area, so housing is really high here).

Fortunately, we are pretty happy to live without a lot of wants, so it’s ok that we don’t have have much extra money left for wants.

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Sara

11 years ago

To RC and Ethan Gunderson: My opinion is that the minimum payments towards your student loans (the “amounts due”) fall under “needs” since you have a contractual obligation to pay them, but anything above the minimums you put towards paying off your student loans falls under “savings” since you are reducing your debt voluntarily.

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Chris

11 years ago

Good post JD.

I just went through our own numbers and came up with the following breakdown:

Expenses 64% – Housing 25% – Other Needs 16% – Wants 23% Savings 36%

I think we are pretty happy with our balance since we are fairly young (early-to-mid 30s) and have some flexibility in our spending. We have also done well to keep our Housing costs down in our very expensive area of the country. Also we are lucky that our “Wants” are not very expensive.

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Chill Bear

11 years ago

Chris #39:

A special thing happens when you put 50% of your take home into savings.

It becomes your retirement plan!

For every day I work, that’s one more day sooner I can retire, as long as I am saving 1/2 my take home. Details on capital preservation, inflation, etc. really are just details. My 3%/yr was laughable in January, now people are envious.

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April

11 years ago

“I’m proud of paying off my past and providing for my future, but maybe it’s time to spend a little money on today.” How timely. Yesterday at the grocery store, I was debating whether or not to buy a $.99 bar of dark chocolate. I mean really debating. We’ve paid off all of our credit card debt and our last car payment will be mailed off next month. We have an emergency fund going. I think I went from being a careless spender to being a compulsive saver who has to evaluate everything I buy. I’m going to lighten up… Read more »

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Ron

11 years ago

Well I can see I need to work on the Spending Plan. I think Less Wants and More Savings are called for.

Expenses 21% – Housing 10% – Other Needs 11% – Wants 49% Savings 30%

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Marcia

11 years ago

The charity comment is interesting. I don’t donate 10% to charity. Why don’t I? I don’t know. I guess since I grew up poor, I am focused strongly on paying off the mortgage and saving for college and retirement.

And our taxes are pretty high, and that’s charity too. I figure I’ll never get social security, so each payment is – well, charity to someone else. 10% for us is 5 mortgage payments. That’s a lot of dough.

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JasonMoran

11 years ago

Yuck… 83.6% Needs 14.1% Wants (Includes tithing) 2.3% Savings

No wonder it’s been so hard to save!

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cv

11 years ago

J.D., I think the virtue of a formula like this is that it’s not a specific allocation of “25% for housing and about 25% for all other needs”. Housing costs vary so much that it’s nice to have a formula that people in all areas and situations can use to discuss and compare their finances. Young urbanites are likely to spend more on rent, less on utilities (smaller space to heat/cool), less on transportation (no car), and more on food (higher prices) than their suburban counterparts. There are probably people out there who pay 10% for housing (such as a… Read more »

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Aya @ Thrive

11 years ago

That’s a great equation, and what makes it better is your explanation of how it can’t be and doesn’t have to be strictly followed, but it is more of a suggestion. I think the 50% needs can be broken down further because I feel like some people could mix up some wants as needs, or some needs could be in savings. Plus, some people spend less on bills or groceries – would the left over money be pushed into savings or elsewhere?

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Nick

11 years ago

I’ve been trying to stick to a similar strategy for a while now, and although it’s hard sometimes (when tuition is due, out of work, etc.), it’s a good base most of the time. I try to save more when I can, and spend about a third of my savings on short term things (vacations), and the rest on more long term goals.

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nonskanse

11 years ago

41% save 34% need 25% want

I’d much rather reduce the “need” by moving into a cheaper place if I’m to up the “want”. As for this: “Maybe your budget will be balanced, but you may become spiritually unbalanced.” Then I guess I’m unbalanced, since I’m not interested in giving to charity.

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Sam

11 years ago

April (#41) – This is something I’m working on too. Once we changed our spending habits, paid off all our non-mortgage debt and got on a spending plan, I realized that I’ve changed a big personal characteristic (my spending, shopping, saving habits). Now that we have our debt paid off (except the mortgage, which we are working on) have a fully funded emergency fund, and have 90% of our 2008 savings goals completed its time to lighten up a bit and spend a little more or at least save for something fun (i.e. vacation). #46 – I think the charity/tithing… Read more »

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Anne

11 years ago

I agree with cv in #45. I’m 26 and I’ve had a really hard time with more specific budget plans. I was staring blankly at the pearbudget spreadsheet this weekend completely frozen. I take out $400 a month for groceries and “whatever” (about 18%). That works for me. I feel no need to break it down beyond that. What I do need is to start planning for what to do with my savings once I get my EF up to snuff. This is much easier to get my head around. It makes it easier to focus on broad goals, which… Read more »

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Hi! I’m J.D. Roth. I'm here to help you master your money — and your life.

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